[Feature] Reflection on the USDC Incident: Is the Idea of A "Perfect Stablecoin" a Fallacy?

Compiled by: Coinlive
Author: Odaily

On March 16th, Circle announced that it had essentially cleared all backlogged USDC minting and redemption requests. This also means that USDC has largely weathered the anchor crisis caused by the collapse of Silicon Valley Bank.

Looking back at this event, from the time Circle disclosed that it held $3.3 billion in reserve funds at Silicon Valley Bank, to the announcement by the US Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) that depositors could withdraw all funds, USDC, once considered a compliance benchmark for stablecoins, suffered a significant anchor break due to market panic, falling to a low of $0.877.

In addition, due to the use of USDC as the primary collateral asset, the two largest decentralized stablecoins in circulation, DAI and FRAX, were also quickly affected. The excess collateral mechanism relied upon by the former and the AMO module of the latter did not have the expected stabilizing effect, and the anchor curve and discount range of both stablecoins were almost indistinguishable from USDC.

No one can escape risk.
"Can holding stablecoins also result in losses?"

This is something that many investors in the industry have never considered. Although the anchor breaks of USDC, DAI, and FRAX were ultimately a false alarm, what kind of stablecoin can guarantee "stability" has become a focus of industry attention.

Over the past few days, we have seen many discussions on related topics. Some discussions have focused on stablecoins that were unaffected in this crisis (such as USDT, TUSD, LUSD, sUSD), attempting to find a direction for the "perfect stablecoin."

However, a closer look reveals that these stablecoins all have different types of risks.
The situation with USDT is already a well-worn topic. Although it was an indirect beneficiary of this event, its issuance has grown to around $75 billion, but the opaque reserve status always looms over USDT as a double-edged sword.

TUSD, like USDC, is a centralized stablecoin with transparent reserve status, so theoretically speaking, what happened to USDC could be repeated with TUSD, except this time it happened to be Silicon Valley Bank that had the issue while TUSD's reserve funds are primarily held in Capital Union Bank in the Bahamas.

The situation with LUSD and sUSD deserves further elaboration. As decentralized stablecoins generated solely by overcollateralized native crypto assets (ETH for the former, and SNX for the latter), they have effectively avoided the risk that stems from the banking system in this incident. However, this collateral mechanism inevitably results in problems such as inefficient use of funds (such as sUSD's requirement of a 400% collateralization ratio) and slow issuance expansion.

From a safety perspective alone, stablecoins like LUSD and sUSD are not without risk - in extreme market conditions, the liquidation efficiency of collateral assets will directly affect the protocol's health. Maker, for example, went down this road at one time, but ended up with bad debt of about $4 million in the historical market fluctuations of March 12, due to untimely liquidation, and only gradually deepened its ties with the seemingly transparent USDC afterwards.

Overall, it seems that no stablecoin can perfectly isolate all risks and achieve the state of "I am immovable despite thousands of dangers". This prompts us to reflect on whether the so-called "perfect stablecoin" is actually a false proposition.

"Risk" and "Hedging"
Let's return to the origin of stablecoins.
Cryptocurrencies are a niche industry with high barriers to entry for those with weak demand and high risks for those with strong demand. Stablecoins have emerged to address these issues, providing entry and exit channels for those with weak demand and exchange media for those with strong demand.

The fragility of stablecoins lies in their need to bear the dual risks from both the crypto world and the real world as a bridge between the two. In the crypto world, this may manifest as fluctuations in collateral assets, hacker attacks, and so on, while in the real world, it may manifest as reserve shortfalls, liquidity tightening, and so on.

Currently, existing stablecoins on the market all need to bear risks from both ends, but with completely different risk compositions.

Take the unpegged USDC as an example, whose main risks come from the real world.

As for another unpegged stablecoin, DAI, due to the risk transmission from USDC, it also needs to bear a certain amount of real-world risks, but due to the existence of the exposure limit, the overall risk situation is relatively lower than that of USDC. However, because a significant portion of DAI's collateral is native crypto assets such as ETH, it also needs to bear a certain amount of risks from the crypto world.

As for LUSD and sUSD, their main risks come from the crypto world.

Therefore, we can construct a simple mathematical model, assuming that the risk coefficients from both the real world and the crypto world are both 1. The risk composition of USDC may be 0.9 + 0.1, that of DAI may be 0.7 + 0.3, and that of LUSD and sUSD may be 0.1 + 0.9. As for USDT and some uncollateralized algorithmic stablecoins, the numbers on both ends may exceed 1.

Based on this evaluation system, we have also rethought the future development trend of the stablecoin track. Rather than seeking a "perfect stablecoin", we are more inclined to believe that in the future, there will still be multiple stablecoins with completely different risk structures coexisting, and they can be used as a hedge against each other.

Cryptocurrencies have always been a high-risk industry, with a constantly changing and diverse set of external "accidents" determining the continued evolution of the definitions of "risk" and "hedge". This has also led to the roles of "risk assets" and "hedge assets" being interchangeable in different circumstances. In this banking crisis, LUSD and sUSD became "hedge assets" for USDC, but in extreme market conditions, USDC may also become a "hedge asset" for them.

For the cryptocurrency industry, as the industry continues to develop, more unforeseeable risks will continue to emerge. What we need to do is to face up to the risks and better manage them.